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With the People's Bank of China continuing to "control the market", the bond market has been repeatedly pulled between long and short sides. On August 13, the yield of medium and long-term government bonds declined, but looking back at the past week, the yield curve of medium and long-term government bonds has shown a steep upward shift as a whole, with a considerable correction.

Market experts said that the recent issuance of government bonds has accelerated significantly, and short-term speculation in the market has also decreased, which indicates that the supply and demand of the bond market is expected to further balance, and the financial management departments have taken turns to remind investors of risks. In addition, the People's Bank of China has increasingly emphasized reminders to investors in the process of "controlling the market". In response, some bank wealth management subsidiaries have also released signals that they may adjust their asset allocation in the future.

"The People's Bank of China's original intention may not be to significantly raise interest rates. It is more about avoiding the formation of unilateral expectations and their continuous strengthening. The improvement of fundamental expectations is the fundamental." The fixed income research team of Huatai Securities believes that the People's Bank of China's regulatory measures are related to financial stability and policy credibility.

In the view of Wen Bin, chief economist of China Minsheng Bank, it is not ruled out that the bank will continue to use expectation management, window guidance, buying and selling of treasury bonds, regulatory constraints and other methods to reduce interest rate risks, timely correct and block the accumulation of financial market risks, and prevent the further strengthening of unilateral expectations of interest rates, thereby forming potential risks such as Silicon Valley Bank.

Bond market at a crossroads

On August 13, the yields of government bonds collectively fell slightly. As of 15:30 on August 13, the yield of active 10-year government bonds was 2.2225%, and the yield of 30-year government bonds was 2.3975%.

Looking back at the past week, the medium- and long-term treasury bond yield curve has shown a steep upward shift. On August 5, the interest rate of active 10-year treasury bonds once fell below 2.1%, and the interest rate of active 30-year treasury bonds once fell below 2.3%, setting a new historical low. However, after that, long-term interest rates rose sharply. On August 9, the 10-year treasury bond yield rose by 7.09 basis points compared with the previous Friday.

On August 12, the yields of major interbank interest-bearing bonds continued to rise. Wind data showed that the yield of active 10-year treasury bonds rose by 4.25 basis points to 2.2425%, while the yield of 30-year treasury bonds rose by 5.25 basis points to 2.4325%. So far, the yield of 10-year treasury bonds has wiped out all the declines since July 26.

"The recent adjustment in the bond market is quite large, reflecting the fact that under the low interest rate environment, the bond market has become more competitive," said Mingming, chief economist of CITIC Securities. In summary, the factors that triggered this bond market correction include institutional behavior, regulatory guidance, and fundamental data.

As Mingming said, one of the turning points - regulatory guidance - occurred when the curve bottomed out. At the end of August 5, under the guidance of the People's Bank of China, major banks began to sell a large number of 24 interest-bearing treasury bonds 11, and the yield rate reversed in a "V" shape, reversing the rapid downward trend of interest rates.

On August 7, the China Interbank Bond Dealers Association launched a self-discipline investigation into a number of commercial banks, and issued an announcement on the 8th stating that it would investigate and deal with the lending of bond accounts and profit transfer practices of small and medium-sized financial institutions.

The bond market is once again at a crossroads. In the "China Monetary Policy Implementation Report for the Second Quarter of 2024" (hereinafter referred to as the "Report"), the People's Bank of China once again emphasized that "we will deepen the reform of interest rate marketization, improve the market-oriented interest rate formation, regulation and transmission mechanism, and gradually straighten out the transmission relationship from short to long. We will strengthen the guidance of market expectations and pay attention to the changes in long-term bond yields during the economic recovery."

In Wen Bin's view, this is the People's Bank of China's re-warning of the risk of a bond market correction in the context of long-term bond interest rates having deviated from the reasonable central level. Combined with the People's Bank of China's statement of "stress testing the risk exposure of financial institutions' bond assets to prevent interest rate risks", as well as the recent guidance on large banks to sell bonds and the launch of self-discipline investigations on the concentrated bond purchases of rural commercial banks in some regions, the People's Bank of China will further strengthen supervision over institutional bond allocation and interest rate curve adjustments in the future.

From expected guidance to final operation

In fact, since April, the People's Bank of China has been constantly warning that excessively low long-term bond interest rates may pose risks.

First, concerns were expressed at the Monetary Policy Committee's regular meeting in the first quarter of 2024, and then through interviews with the Financial Times and columns in monetary policy reports, he continued to remind people of the potential risks of long-term government bond interest rates.

"At present, we should pay special attention to the maturity mismatch and interest rate risk of some non-bank entities holding a large number of medium- and long-term bonds, maintain a normal upward-sloping yield curve, and maintain the market's positive incentive effect on investment." On June 19, Pan Gongsheng, governor of the People's Bank of China, issued a bond market risk warning in the form of the Silicon Valley Bank case at the Lujiazui Forum, once again expressing the People's Bank of China's high concern about long-term bond yields.

In late June, the 10-year treasury bond yield approached the 2.2% mark, a 20-year low. Then, on July 1, the People's Bank of China continued to release a big move, announcing the launch of treasury bond borrowing operations, and when necessary, it will choose to sell in the open market to balance the supply and demand of the bond market and correct and block the accumulation of financial market risks. Then on July 8, the People's Bank of China issued an announcement that it would carry out temporary positive repurchase or temporary reverse repurchase operations from 16:00 to 16:20 in the afternoon, depending on the situation.

From guiding large banks to selling bonds and other "combination punches", in response to the continued hot bond market, the People's Bank of China has shifted from "expectation guidance" to "off-site operations".

The abnormal fluctuations in the treasury bond market are due to the large amount of funds hoarded and speculated by financial institutions and the influx of large amounts of funds into the market, while the yields are not satisfactory. Small and medium-sized banks "bet" that interest rates will fall further, and buy long-term bonds in the hope of earning the difference in the future, causing confusion in interest rate expectations. Behind this, it is obviously contrary to the People's Bank of China's concept of "smoothing the monetary policy transmission mechanism and improving the efficiency of fund use". At the same time, once interest rates rise, small and medium-sized banks themselves are prone to repeat the "Silicon Valley Bank" risk. The continued decline in long-term interest rates in the bond market has also led to a widening of the interest rate gap between China and the United States, which will also put certain pressure on the foreign exchange market.

Yang Haiping, a researcher at the Securities and Futures Research Institute of the Central University of Finance and Economics, further explained that the main reason why the People's Bank of China started this round of bond market regulation was the continued asset shortage and weak expectations of investors for the macro economy, which led to the continued overheating of the treasury bond market. The overheating of the treasury bond market may lead to the accumulation of risks - the distortion of long-term treasury bond yields has increased the pressure of capital flight; it has also increased the tendency of capital speculation and weakened the willingness to support the real economy.

After the frequent calls, the market has not yet fully returned to rationality. Take the 10-year active treasury bond 240011 as an example. Since July 9, the yield has fluctuated downward, from 2.263% to 2.1175% on August 1. On August 5, the bond market continued to strengthen due to the intensified turmoil in overseas markets and the sharp rise in risk aversion demand. In the view of analysts, the People's Bank of China's move to "put out the fire and cool down" is timely.

"The original intention of the People's Bank of China is not necessarily to raise interest rates significantly, but to avoid the formation of unilateral expectations and continue to strengthen them. The improvement of fundamental expectations is fundamental." Huatai Securities' fixed income research team commented. As the ultimate lender, the People's Bank of China has the responsibility to stabilize the macro environment and reduce market volatility, and the core of macro-prudential management is to smooth out financial procyclical fluctuations. In addition, the control effect of this round of bond market yields also affects the credibility of the monetary authorities.

On the other hand, the People's Bank of China has increasingly emphasized the reminders to investors in the process of "controlling the situation". As the column of the "Report" further pointed out, "Since the beginning of this year, the annualized yield of some asset management products, especially bond-type wealth management products, has been significantly higher than the underlying assets, mainly achieved through leverage, and there is actually a large interest rate risk. When market interest rates rise in the future, the net value of related asset management products will also fall sharply."

The People's Bank of China pointed out that as the asset management industry further transforms towards net value, investors will gradually bear more risks of net value fluctuations. When financial institutions sell asset management products, it is necessary to provide good investor services, provide relevant consultation, fully inform investors of risks, guide investors to view net value fluctuations rationally, and promote the stable and healthy operation of the market.

Some analysts believe that the People's Bank of China's guidance on long-term bond yields will be managed from multiple dimensions: "opening up the regulatory mechanism + reminding the assets themselves + reminding financial institutions of risks + increasing the risks of public investors."

Institutions release signals of asset allocation adjustments

At present, the downward trend of long-term treasury bonds has been suppressed to a certain extent. Have the returns of bank wealth management products and bond fund products purchased by investors also been affected? An investor told the Beijing Business Daily reporter that "the returns of the bond funds invested have indeed been adjusted since August 8". Another investor also said, "Although the annualized yield of this bond-type bank wealth management product I bought has fallen in the past two days, the overall annualized yield is still above 3%."

The appearance of this scene reminded many investors of the scene in 2022. At that time, the bond market fell, causing many fixed-income wealth management products and bond funds to decline, which also triggered a "redemption wave". After the second half of 2023, the bond market began to gradually stabilize, allowing bank wealth management products and bond funds to achieve good performance returns.

Will this phenomenon happen again today? Ai Yawen, an analyst at Rong360 Digital Technology Research Institute, pointed out in an interview with a Beijing Business Daily reporter that the People's Bank of China's borrowing bonds and selling bonds, and the increase in government bond supply, have increased short-term bond interest rate fluctuations and avoided unilateral trends. Bond interest rate fluctuations will directly affect the yield of fixed-income products in the bank wealth management and fund markets, and will also lead to adjustments in the fixed-income asset allocation of banks or funds. However, the scale of the bank wealth management and fund markets is ultimately determined by supply and demand, not central bank intervention. The medium- and long-term trend of the bond market has not been reversed, and it is highly unlikely that the scale of the wealth management and fund markets will shrink.

From the perspective of industry data, according to the "China Banking Wealth Management Market Half-Year Report (2024)", as of the end of June, the bank wealth management market had a total scale of 28.52 trillion yuan, a year-on-year increase of 12.55%; data from the China Securities Association showed that as of the end of June, there were 163 public fund management institutions in my country, including 148 fund management companies and 15 asset management institutions with public offering qualifications. The net asset value of the public funds managed by the above institutions totaled 31.08 trillion yuan.

As Zhou Maohua, a researcher at the Financial Market Department of Everbright Bank, said, considering that since the beginning of the year, bond interest rates have fallen significantly, bond prices have remained high, and investors have accumulated rich profits, the short-term bond market adjustment is bound to lead to a slowdown in the growth of the scale of some wealth management products such as wealth management and bond funds, or even a decline. However, the specific changes in scale depend on the adjustment of the net value of the relevant wealth management products, the income relative to deposit products, and the market's expectations for the economic and policy prospects.

With the adjustment of the bond market, institutions have also realized the importance of adjusting asset allocation strategies. A person from a relevant department of a wealth management company said in an interview with a Beijing Business Daily reporter that the People's Bank of China's operation of borrowing and selling treasury bonds may push up bond yields, which will directly affect the performance of wealth management products. With the intervention of the People's Bank of China, wealth management companies may adjust their asset allocation strategies, reduce their reliance on bonds, and turn to other asset categories, such as the stock market, to attract investors by increasing equity asset allocation or launching more stable income products. Another person from a joint-stock bank wealth management company said, "Currently, changes in the bond market have little impact on the wealth management market, and the possibility of adjusting asset allocation in the future cannot be ruled out."

From the perspective of investors, it is also necessary to pay attention to the risks brought by the adjustment of the bond market. Ai Yawen suggested that investors can pay attention to interest rate risk, liquidity risk and policy risk, such as changes in the yield curve, and the impact of possible interest rate hikes or cuts on the investment portfolio. Investors should also ensure that there are enough liquid assets in the investment portfolio to cope with possible redemption needs or market changes. At this stage, asset allocation recommends diversified investment, balancing risks and returns, and maintaining a certain amount of cash or cash-like assets.

Zhou Maohua emphasized that the adjustment in the bond market initially reflects the change in the market's expectation that the bond market will continue to rise. Some funds have flowed out, and it is not ruled out that some asset management institutions will take profit and adjust their corresponding strategies. However, it is not ruled out that there will still be divergent tug-of-war in the short-term market. If there is a consistent bearish view in the short term, bond volatility may be amplified. Investors need to avoid irrational following and be alert to potential market volatility risks. After the net value transformation, the investment returns and risks of domestic wealth management products are more symmetrical. High returns are accompanied by high risks. While investors pay attention to returns, they need to comprehensively consider their own risk tolerance and reasonably diversify their investments.

However, some people from financial management companies also said that short-term long-term bond yields may enter a period of wide fluctuations. The next stage will focus on the impact of fiscal policy on fundamentals, liquidity and supply and demand. Before the trend is reversed, adjustments will still be an allocation opportunity, and dumbbell strategies will prevail.

Long-term bond yields may enter a phase of consolidation

However, in the view of the fixed income research team of Huatai Securities, if regulation is to be effective, it is necessary to change the supply and demand relationship in the bond market or the fundamentals and monetary policy expectations.

If it still doesn't work, what additional tools will be used? Huatai Securities' fixed income research team mentioned that one is to directly tighten the funding side. The second is that the People's Bank of China borrows treasury bonds to sell. This measure can not only recover liquidity, but also increase the selling of treasury bonds. It will also have a direct impact on the bond market yield, but there are many concerns. The third is to continue to provide window guidance to market institutions, or impose additional regulatory measures. The essence of this behavior is to suppress demand and reduce market liquidity, and change the supply and demand pattern in stages.

Wen Bin also said that the People's Bank of China and financial regulatory authorities will continue to use expectation management, window guidance, buying and selling treasury bonds, regulatory constraints and other methods to reduce interest rate risks, timely correct and block the accumulation of financial market risks, and prevent the further strengthening of unilateral expectations of interest rates, forming potential risks such as Silicon Valley Bank. By maintaining a normal upward-sloping yield curve, maintaining the positive incentive effect of the market on investment, and stabilizing economic growth expectations and exchange rates, we can promote the connotation-oriented development of finance and long-term financial stability.

It is worth mentioning that regulatory tools are not limited to selling bonds. Many market factors may also trigger changes in bond yields. For example, during the accelerated issuance of government bonds, the liquidity of the banking system may fluctuate, driving up the yields of medium-term, long-term and ultra-long-term bonds. In addition, analysts believe that it is worth paying attention to when the government bond trading and overnight repurchase operations will be implemented.

"The long-term bond yield may enter a phased consolidation process in the future." Feng Lin, director of the research and development department of Orient Securities, told the Beijing Business Daily that the new low in long-term bond yields triggered the People's Bank of China to launch substantial measures to manage bond market risks last week, but no temporary repurchase or borrowing and selling operations were carried out. On the one hand, this reflects that the People's Bank of China has a rich means of managing bond market risks. On the other hand, it may also be due to the current weak fundamentals and the need for fiscal efforts that have constrained the strength of its relatively tight policies.

In line with the report's proposal to "maintain stable liquidity while avoiding overheating of the bond market; stabilize growth while preventing risks", Feng Lin believes that overall, the current long-term bond yield may have reached a reasonable central level, and it is unlikely that the People's Bank of China will continue to guide the long-term bond yield to rise rapidly. It is expected that the short-term fluctuation range of the 10-year treasury bond yield will be between 2.1% and 2.3%.

Mingming pointed out that in the future, if the reserve requirement ratio is lowered to release medium- and long-term liquidity, it can support the issuance of national bonds and local bonds, avoid excessive supply shocks to the market and raise government financing costs. The reserve requirement ratio cut can boost investor confidence, thereby stabilizing the capital market, especially the performance of the equity market. Therefore, the People's Bank of China may still cut the reserve requirement ratio this year, with the range possibly being 25 basis points, releasing 500 billion yuan of liquidity; if the reserve requirement ratio is not lowered in the short term, there is a high probability that liquidity will be released through OMO. In an environment where the expectation of loose money is still clear, it is expected that the overall strengthening pattern of the bond market will continue.

Beijing Business Daily reporter Song Yitong and Dong Hanxuan